Ravshan Suyunov

1201193010
October 2019
BBA
Semester 4

Answers

Section A

Question 1

A and B

Year Nominal GDP Real GDP

2017 (100*10)+(50*100)+(10*200)=8,000 (100*10)+(50*100)+(10*200)=8,000
2018 (100*12)+(52*108)+(10*205)=8866 (100*12)+(50*108)+(10*205)=8650
2019 (100*12)+(54*115)+(10*212)=9530 (100*12)+(50*115)+(10*212)=9070

Percentage Change = ((2ND year real GDP – 1st year real GDP)/1ST year real GDP) *100%

2017 to 2018 = (8,650-8,000/8000) *100%=8,125 %

2018 to 2019 = (9,070-8,650/8650) *100%=4.85%

GDP deflator = (Nominal GDP/Real GDP) *100

2017 = (8,000/8,000) *100%=100

2018 = (8,866/8650) *100=102.5

2019 = (9530/9070) *100 = 105.07

As we can see above with numbers, economic well-being has been increased. In both Nominal and Real
GDP, numbers have been increased from 8,866 to 9530 and from 8650 to 9070 respectively in 2019.
Percentage change remained positive with 4.85% and GDP deflator also has increased from 102.5 to
105.07. So overall, we can analyze the growth in economic well-being with numbers.

Question 2

A
1.If the initial output is RM10 billion, it means that the initial aggregate demand curve is AD1.In this
case, a tax cut of RM20 billion will move AD1 to the right. The reason lies in the decrease of tax revenue,
the increase of people's disposable income and the increase of demand. And at the same time, we can
see that AD1 is going to move to the right to AD2 firstly.

2.If Y3 represents the final change in AD, that is, the tax moves the AD curve from AD1 to Y3. Since the
tax rate is not mentioned in the question, suppose the tax rate is equal to 0.1, then the tax multiplier =-
0.5 (1-0.1) /1-0.5 (1-0.1) ≈0.8, in which case, Y3=20*0. 8+10=26.Assuming the tax rate is equal to 0, then
the tax multiplier =-0.5/1-0.5=1, in which case Y3=20*1+10=30.That is to say, a tax cut of RM20 billion
increases the output by RM20 billion.

1.Assuming the tax rate is equal to 0 and Y3=30, then the government multiplier =1/1-MPC=2.The
government's fiscal measures shifted the aggregate demand from AD2 to AD3, increasing the output
from RM20 billion to RM30 billion, the required amount of changes in government spending= (30-20)
/2=RM5 billion.

2 It is the increase in government spending that raises aggregate demand and thus the level of social
equilibrium output.

Section C

Question 1. (12 marks)

The demand for loanable fund is inversely related to interest rate in contrast to the supply of loanable
fund. Briefly explain the reasons behind this condition using a diagram.

The supply of loanable funds comes from saving:

Households with extra income can loan it out and earn interest.

Public saving, if positive, adds to national saving and the supply of loanable funds.

If negative, it reduces national saving and the supply of loanable funds.

The demand for loanable funds comes from investment: Firms borrow the funds they need to pay for new
equipment, factories, etc. Households borrow the funds they need to purchase new houses.

Question 3. (16 marks)

There are several factors may increase the aggregate demand (AD) at a given price level. Explain the
FOUR (4) factors regarding these changes.

Changes in C
Stock market boom/crash
Preferences re: consumption/saving tradeoff
Tax hikes/cuts

Changes in I
Firms buy new computers, equipment, factories
Expectations, optimism/pessimism•
Interest rates, monetary policy
Investment Tax Credit or other tax incentives
Why the AD Curve Might Shift

Changes in G
Federal spending, e.g. Defense
State & local spending, e.g. Roads, schools

Changes in NX
Booms/recessions in countries that buy our exports.
Appreciation/depreciation resulting from international speculation in foreign exchange market
(Used from Lecture 2 notes)

Question 4. (10 marks)

Although the goal of the consumer price index is to measure changes in the standard of living, it is not a
perfect measure of the cost of living. Discuss with some examples.

The three problems in the consumer price index as a measure of the cost of living are:

Substitution bias: Over time, some prices rise more than others. Consumers will substitute goods that
have become relatively less expensive. The CPI, however, is based on a fixed basket of purchases.
Because the CPI fails to acknowledge the consumer’s substitution of less expensive products for more
expensive products, the CPI overstates the increase in the cost of living.

Introduction of new goods: When new goods are introduced, a dollar has increased in value because it
can buy a greater variety of products. Because the CPI is based on a fixed consumer basket, it does not
reflect this increase in the purchasing power of the dollar (equivalent to a reduction in prices). Thus,
again, the CPI overstates the increase in the cost of living.

Unmeasured quality change: If the quality of a good rises from year to year, as with tires and computers,
then the value of a dollar is rising even if actual prices are constant. This is equivalent to a reduction in
prices. To the degree that an increase in quality is not accounted for by the ABS, the CPI overstates the
increase in the cost of living. The opposite is true for a deterioration of quality.